Chart of the Day, 3 Feb 2015: US Shale Oil and the Coming Production Cliff

The impact of shale oil, otherwise known as tight oil or light-tight oil (LTO), in the United States is indisputable. Aggregate production (conventional and non-conventional) is now almost level with its 1970 peak (click for larger image) with shale leading the oil rennaisance.

Indeed, US production was 9 million barrels per day in November, a rise of 14.5% over the same period the previous year

How long will it take for production to adjust if crude stays around $50 per barrel? As I’ve mentioned before, shale is an industry with high upfront costs but relatively low operating and maintenance costs. The upfront costs are already ‘sunk’, so the ‘pump’ or ‘don’t pump’ break-even point is as low as $10-20 per barrel. Moreover, many producers hedge to varying degrees. To get a taste of this, here is part of a table on listed shale oil producers published at Seeking Alpha.

Once these hedges roll off, profit margins will collapse. Meanwhile, the output of shale wells declines by around 60% in the first year; therefore, sustained production requires continuous new investment. And new investment requires a decent return on investment. Reuters has a good article by John Kemp on how this dynamic works.

Bloomberg New Energy Finance estimates that to sustain current levels of shale oil production would require a return on investment of 10%, but to increase production would need a 20% return (see their White Paper here). Using these rates, they then go on to look at what oil price is required for each region to get such returns (click for larger image).

Based on these calculations, the US oil industry will fall off a cliff should the oil price remain below $50 for more than a year.

Bottom line: shale oil has not killed peak oil, but cheap oil will kill shale. The only way this won’t happen is if the oil price moves back up again–which I forecast it will.

As Colin Campbell and Jean Laherrere said in a prophetic 1998 article in Scientific American, “The world is not running out of oil–at least not yet. What our society does face, and soon, is the end of abundant and cheap oil on which all industrial nations depend.” As I said yesterday for natural gas, to prove Campbell and Laherrere wrong we need to see low oil prices and rising production–not one without the other. It’s a simple test. Let’s see what happens.

One response to “Chart of the Day, 3 Feb 2015: US Shale Oil and the Coming Production Cliff”

Exactly. And as you also noted, that situation must last for more than a few months.

The EROI of oil is declining faster and faster, but demand for oil is relatively inelastic. I do not see how the price or oil can remain low unless that price is high relative to other equally demand-inelastic commodities. This means that in order for oil prices to remain at current lows, world economic activity must decline substantially. If oil is a leading indicator, that decline may be well under way and we just have not seen it in official statistics.